Linking the BOPC growth model with foreign debt dynamics to goods and labour markets: A BOP-IXSM-Okun model

Abstract

We link a BOPC growth model to the goods market, foreign debt dynamics, and Okun's law. A new condition for getting the Thirlwall effect of world GDP growth on domestic growth is that investment and export shares of GDP should react less to an increase in the domestic growth rate than savings and import shares. If this condition holds, the Thirlwall effect is present for the equilibrium point of stable and unstable debt/GDP dynamics and for positive or negative reactions of the current account to domestic growth. Okun's law translates the effect on the domestic GDP growth rate to a change of the unemployment rate. Under unstable debt/GDP dynamics, the change of world GDP growth may turn around the direction of the debt/GDP dynamics, a second important foreign growth effect. Estimations support the specification of the theoretical model and lead to simulations of the Thirlwall effect, terms of trade and interest rate shocks on output growth. Profit maximizing bank consortia set interest rates below growth rates ensuring stable debt dynamics in the presence of an interior maximum. Conditions for an interior maximum are empirically violated for Brazil indicating that banks would have to change the economy strongly. A crisis can be less likely through a jump into a steady state for the debt/GDP ratio; unstable, increasing debt/GDP processes through high interest rates cannot be ruled out though and may lead to crises unless the empirics of the stability conditions gets more favourable and leads the country-bank model into a stable steady state or out of indebtedness.